Balanced Fund Update & Market Thoughts

This is a follow up to the article I wrote on Aggressive Savings Techniques using Balanced Funds (for intermediate term). I am not going to do a quantitative analysis right now. I want to wait for the year to end to see where things end up.

But yikes! When I wrote the article, I didn't believe we would enter into the worst economic crisis since the Great Depression. (Don't interpret that line as this crisis is just as bad as the Great Depression. Some people I've talked to make that allusion when they hear this and that is plain wrong. While the current crisis is very bad, it is nowhere as bad as the Great Depression. Perhaps the phrase, 'Only the Great Depression has been worse in the past 80 years' would be more clear.)

So here are some random thoughts I have:

Balanced Funds

Concerning the Balanced Funds, the first thing that struck me was that these funds have dropped around/over 20%. My original risk assumptions placed them around losing 10%. Dodge and Cox is down over 30%. They got hit by holding Fannie Mae, AIG and Wachovia Corp among other things.

Probably another thing I should have talked about (but has always been implicit in my thinking) is manager risk. Holding multiple funds would diversify manager risk (with the flip-side of diluting any superior performance). Going pure-index funds eliminates it completely, though in my original analysis, I ruled out index funds for this category. Currently, the balanced index funds have are also down about 20% which isn't any better.

One thing that did surprise me is that Fairholme continues to behave much like the balanced funds. It is down also in the 20% ballpark. I kind of expected that one to behave more like a regular stock fund in a market crash like this one. Of course, I wonder if it would be better just to buy Berkshire-Hathaway directly instead of Fairholme. Warren Buffet is on a buying spree and I predict he will do very well with these purchases over the long term.

Now to put things in context, Vanguard Total Stock Market Index and the S&P 500 are down 30%-35%. And Vanguard Total International Stock Market is down over 40%. So the balanced funds at least staved off all the damage.

Ultra-Short Term Bond Funds

I didn't mention Ultra-short term bond funds in my previous article. These were also on my radar, but the products were so new, I didn't trust them so much. These funds promised to be almost as safe as a money market (but could lose value), but offered higher yields in return. They were placed between a money market and short term bond fund. It turns out that that my caution was correct. 

Schwab YieldPlus Investor (SWYPX) and Fidelity Ultra-Short Bond (FUSFX) have become the poster children for disaster with these kinds of funds. They both got caught up in subprime loan securities to increase their yields, and these funds collapsed. Schwab is down over 30%. Fidelity is down almost 10%, which isn't as bad, but if you were thinking this was going to be safe like a money market, this looks really bad. Lawsuits are pending.

There are plenty of good articles on this. I didn't think to save any of the links when I read them. The following is not my favorite article, but does cover the basics.

Money Markets and Savings Accounts (i.e. Cash)

Money markets are also a surprise. Several money market funds have broken the buck and there has been worry more will do the same. The US Treasury has stepped in and offered to back these funds if they opt-in so the uncertainty of these will probably go away.

FDIC insurance has gotten a lot of coverage, particularly with the failure of IndyMac Bank. I'm not worried about losing money with FDIC coverage. This is the closest thing to a sure thing. When Washington Mutual and Wachovia were on the brink, they were offering high rates on savings and CDs to raise cash. This was a good deal. Now that WaMu has been bought and Wachovia will be as well, these rates have dropped to typical levels.

Perhaps the biggest surprise to me is that Tax Exempt money market yields are sky-high. The raw rates (not calculating for effective after-taxes which are even higher) are 4%-5%. Apparently, because everybody is afraid of loans, nobody is buying the short term papers states need to raise money. So they are offering extremely high yields. Assuming the states don't default, this is a real great deal. I think the Fed is insuring these money markets too, so maybe there is little risk. (I have not read up on the details.)

Though California is worried it will not be able to borrow the money it needs in a month so But I'm not sure what that really means with respect to risk for these funds. 

At Vanguard, the regular tax exempt money market is yielding over 5%, so if you are in California in the 25%/9.3% bracket, the tax exempt currently works about about the same or slightly better than CA Tax Exempt, so for this moment, it is probably better to stay in regular tax exempt. as a microcosm for the lending mess?

On an aside, another thing I've been casually following out of interest is It is a person-to-person lending site. Think: Doing loans on eBay. I thought it was an interesting idea, but I have been cynical on several issues such as background checks on people, the going market rates on loans, and what happens on default loans. When I first looked at the site over a year ago (maybe two?), it seemed to me that people were lending money too easily to people with bad credit ratings and not demanding high enough rates to compensate for potential defaults. My feeling was a lender would likely lose money.

At this period in time, money markets and savings accounts were actually beating short term bonds. I also looked high-yield bond funds, and similar to Prosper, I felt the rates were too low for the risk. All of these factors at the time led me to believe that there was too much money in the market for lending which is what originally steered me to my balanced fund strategy to try to capitalize on equities (and tax benefits) rather than loans.

So it appears I was probably right about loans/bonds. (Too bad stocks have been heavily correlated in this financial disaster.) For comparison, Vanguard's high yield bond fund is down around 15%. Vanguard is typically more conservative than other high-yield funds. Right now, a 15% loss is looking better than 20% in a balanced fund, but for context, this ignores the potential return in growth years. Looking at these numbers, it is still my opinion, the (after-tax) return on high yield funds doesn't seem to justify the risk compared to balanced funds. 

To drive the point, from, these are the tax-adjusted returns for Vanguard High-Yield Corporate Bond Fund (VWEHX) and Wellington (VWELX).

Tax-adjusted returns

3-yr Avg %

5-yr Avg %

10-yr Avg %









Anyway, concerning Prosper, it appears that defaults are on the rise. Furthermore, there are criticisms of fraud and not enough being done to recover assets on defaulted loans. There are some blogs criticizing their experiences on Prosper such as this one:

which seem to validate my original concerns.

But I see a lot of parallels with the happenings at Prosper with what's going on in with the subprime mess as a whole. Make risky loans with people unlikely to be able to pay back, and you will see lots of defaults. 


I'm not sure if I have any conclusions at this point, except understand your risk tolerance and asset allocation. The one thing about the crisis is you can see first hand how badly things can be hit.

Maybe one lesson is not to borrow more than you can afford, but my fear is that with all the government bailouts, responsible taxpayers may end up paying to bailout those irresponsible and the latter will make out like bandits, in which case the real lesson is to act irresponsibly because if enough people do it, you will get free money from others.

But I want to end on a positive note. I'm still hopeful that the market will bounce back. I think everything is a good buying opportunity right now, so now is time to purchase more and/or stay the course. I believe America will get through this and best days are still ahead.

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